Talking Telecoms With Mobile TeleSystems

For almost as long as dividend-seeking investors have been seeking dividends, the telecommunications sector has beckoned. Here in the U.S. of A., telecom giants AT&T (NYSE: T) and Verizon (NYSE: VZ) offer some of the biggest dividends around, coupled with copious cash flows; stable, essential businesses; and near-monopoly status in many markets. Even more rural telecom providers, such as Windstream (NYSE: WIN) and Frontier Communications (NYSE: FTR) , offer dividends above 7.0%. But did you know that other countries have telephones, too? And public companies that profit from them? In which you can invest?

A few weeks back, Fool contributor Rich Smith dropped by the Moscow offices of Russia's Mobile TeleSystems (NYSE: MBT) to chat with the CFO. Over the course of an hour, MTS CFO Alexey Kornya sketched out the investment case for his company, and gave me insight on "what makes telecoms tick" in the Russian context. What follows is the first of several excerpts from that conversation. It has been edited for clarity, style, and brevity.

Begin at the beginningRich Smith: OK, so could we start off with a brief history of MTS? How did you start? What are some of the biggest changes that have happened since you started and where are you now?

Alexey Kornya: We are the largest mobile operator in Europe, and not only mobile now but we are also a full communication group including fixed and mobile. We started as a mobile operation in 1993 in Moscow, and then as the industry grew we grew with the industry. This is the story of many mobile companies.

We went to the New York Stock Exchange in 2000, and continued our growth from there. And where we stand right now, we've got $11.3 billion in revenues, and we have about 70 million subscribers in Russia.

Smith: At the most basic level, can you explain to an individual investor how does MTS make its money?

Kornya: Well, by providing basic telecommunications services. About 90% of our revenues is providing mobile services -- voice, data, SMS, content, and some other services. And the rest is coming from our fixed line or fixed broadband operations, specifically TV. In cable TV, we're one of the largest cable TV providers in Russia. We have about 10 million households "passed" as a fixed operator, and we own MGTS, which is the Moscow incumbent operation.

So we are present in the most lucrative market in Russia. We have slightly less than 2 million fixed broadband subscribers. We're the No. 3 operator in Russia. And we have about 2.8 million pay TV subscribers, and all of this -- broadband, internet, pay TV and mobile data -- these are the key drivers for our revenues.

Smith: OK, so are cable and fixed telecom going to be the growth drivers going forward, as opposed to wireless?

Kornya: Well in wireless we have data, which drives our revenue. So we're in this stage where data could be durational. Data is also one of the key drivers for the group.

Smith: What about handsets? In Q3, your handset revenues were up 48%, which was much faster than the rest of your revenue growth …

Kornya: Yes, because we were in this stage of quick build up of our retail, our proprietary network. Within two years we grew this from basically zero, where we were at the beginning of 2009. From the very beginning of 2009 we were, you know, only 400 stores, and now we have grown to more than 2,000, 2,300 of our own MTS stores where we sell handsets.

So we took the No. 3 position in the market and we are right now selling 1.5 million of MTS handset sales in a quarter. Last year we sold about 5 million handsets.

Smith: Speaking of handsets, there's something that's always interested me about the Russian telecoms. They'll say "OK, we're at 90% penetration, now we're at 100% penetration, now we're at 120%." How do you even get past 100%?

Kornya: Well, there's a certain business model which allows you to target pricing at different customers. Value seekers, they buy a SIM card, use it, throw it away, and buy a new one. Each time they do this, the buyer counts as a "new subscriber," so one person can buy multiple SIM cards, and eventually give the whole country greater than "100% penetration." So why do this? What advantage does it give you? You are targetedly reducing pricing to specific people who are really looking for value.

For example, say you have a 600-ruble local dealer commission on a 200-ruble SIM card. So dealers give SIM cards to subscribers for free, and the dealers net 400 rubles, which is still quite good and it makes it easier for them to sell the SIM cards.

But if you go down the whole panel of your base, you're clearly giving some discounts to some people who are not probably even looking for them. They don't care that much about how much they spend, or at least they are at a comfortable level where they are spending right now. So that's how this market works, and that is why our dealer commission grew a few times over the last five years. It continues to grow, but at the same time that allows you to sustain relatively high growth rates in revenues. We showed 12% revenue growth in rubles in 2010 in Russia, and taking the appreciation of the ruble into account, we grew 14% in dollar revenues. So that's how it works with the penetration.

Revenue, earnings …Smith: Speaking of growth, Wall Street has you pegged for about 22% earnings growth per year over the next five years. Does that sound like something that's overoptimistic, realistic, conservative?

Kornya: No, I think it's extremely optimistic. Our outlook for the next three years is probably in the low double digits, maybe even about 10%, something like that.

Smith: Is that revenue, earnings?

Kornya: Revenue.

Smith: And do you focus primarily on how fast you're growing revenues or earnings?

Kornya: We are focusing on both the revenues and the earnings, but you know, there is a strong correlation.

… and dividendsSmith: At the end of 2010, you decided on how much to pay for the dividend for 2009. How does that work? Why the delay?

Kornya: We have a dividend policy which says that we are paying over 50% of our net income into dividends. Historically, we paid from 60% to 75% depending on the year and depending on how successful the results were and so forth. Our dividend yield is one of the best in Russia. So how it works, usually the Board of Directors decides on the dividend and then midyear in the shareholders' meeting it is approved. That's how it works.

Smith: Based on what the earnings were from the previous year?

Kornya: Yes.

Smith: OK. I got it.

Kornya: Fifty plus, and usually about 60% to 70%.

This concludes part 1 of our conversation with MTS. Tune in again tomorrow for part 2, or, even better, bookmark this page and check back tomorrow. We'll add a link here for easy clicking over to subsequent installments as they are published. Click here to read part 2, "In Russia, Risk Is a Four-Letter Word."

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